Secular stagnation: US hypochondria, European

Secular stagnation:
US hypochondria, European disease?
Nicholas Crafts
CAGE, University of Warwick and CEPR
After the Great Depression, secular stagnation turned out to be a figment of economists’
imaginations. This chapter argues that it is still too soon to tell if this will also be
the case after the Great Recession. However, the risks of secular stagnation are much
greater in depressed Eurozone economies than in the US, due to less favourable
demographics, lower productivity growth, the burden of fiscal consolidation, and the
ECB’s strict focus on low inflation.
The first time around, ‘secular stagnation’ was a hypothesis famously articulated by
Alvin Hansen in his Presidential Address to the American Economic Association
in Detroit in December 1938 (Hansen 1939). Hansen argued that the US economy
faced a crisis of underinvestment and deficient aggregate demand, since investment
opportunities had significantly diminished in the face of the closing of the frontier for
new waves of immigration and declining population growth. It was as if the US was
faced with a lower natural rate of growth to which the rate of growth of the capital stock
would adjust through a permanently lower rate of investment.
As we all know, these fears were completely without foundation – the delusions of a
hypochondriac rather than the insightful diagnosis of a celebrated economist. Trend
growth in the US regained or even exceeded its pre-Depression rate in the following
decades that were characterised by full employment (Ben-David et al. 2003). The US
economy delivered a rapid rate of TFP growth building on the technological prowess
that it had established prior to the Depression (see Table 1), and this sustained a high
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Secular Stagnation: Facts, Causes, and Cures
level of investment while population growth revived under the auspices of the ‘baby
boom’. Moreover, the textbook antidote for secular stagnation in a depressed economy
at the zero lower bound for nominal interest rates – namely, to cut real interest rates
dramatically by credibly committing to higher inflation – had already been shown to
work by Roosevelt’s New Deal, which delivered a strong recovery in the years after
1933 (Eggertsson 2008).
Table 1 Contributions to labour productivity growth in US (% per year)
K/HW growth
1906-19
1919-29
1929-41
1941-48
1948-73
0.51
0.31
-0.19
0.24
0.76
HK/HW growth
0.26
-0.06
0.14
0.22
0.11
TFP growth
Y/HW growth
1.12
2.02
2.97
2.08
1.88
1.89
2.27
2.92
2.54
2.75
Note: Estimates are for private non-farm economy.K/HW = capital per hour worked; HK/HW = human capital per hour
worked; Y/HW = real GDP per hour worked.
Source: Derived from Field (2013).
The rediscovery of secular stagnation in the context of a sluggish recovery from the
financial crisis of 2008-9 has similar foundations. Forecasts of US economic growth
over a medium- to long-term horizon have been revised down in recent times as the
growth of labour inputs decreases and questions are raised about the future (post-ICTrevolution) rate of technological progress (Gordon 2014), with the result that investment
opportunities are curtailed. Models have been devised in which, faced with shocks of
this kind, it would be necessary to find a way to have a lengthy period of negative real
interest rates to avoid a prolonged slump (Eggertsson and Mehotra 2014). Aggressive
use of fiscal stimulus might be appropriate in this scenario.
It must be said that once again, this could well turn out to be hypochondria rather
than far-sighted prediction. Even after downward revisions, mainstream projections for
growth over the next ten years or so in the US cluster around 2.1% per year for GDP and
1.6% per year for labour productivity. This productivity growth rate would basically
be a continuation of the average performance of the last 40 years (Fernald 2014), with
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Secular stagnation: US hypochondria, European disease?
the main headwind being diminished growth of labour inputs in the face of adverse
demographic trends. The future rate of TFP growth is, of course, quite uncertain and
techno-optimists such as Brynjolfsson and McAfee (2014) imagine a much rosier
future. Be that as it may, it is not obvious why an economy with a steady-state growth
rate of more than 2% per year should have a permanent shortfall in demand or a need
for a permanent negative real rate of interest.
However, the threat of secular stagnation may be much more real for Europe. Although
relatively little attention seems to have been given to this possibility, Europe is surely
much more vulnerable, especially in the Eurozone. There are four obvious reasons for
this, two stemming from economic performance and two from policy responses:
• European demographics are less favourable
• Productivity growth in Europe will underperform whatever US achieves
• Fiscal consolidation in the context of a high public debt ratio will bear relatively
heavily on Europe
• In a depressed economy, the Fed is more likely to take appropriate policy action
than the ECB
Table 2 reports OECD growth projections for 2014-2030. In the context of ageing
populations, Eurozone employment growth is projected at 0.2% per year compared
with 0.5% for the US, and for most European countries the demographics are relatively
unhelpful.
It is clear from Table 2 that pre-crisis productivity growth in Europe generally failed to
match that in the US, as was widely noted at the time. A major reason for this in many
countries was the relatively slow exploitation of the potential of ICT (Oulton 2012).
More generally, productivity growth in European countries was frequently held back by
weak competition, excessive regulation and shortfalls in human capital that particularly
undermined productivity performance in marketed services, where the single market
has been ineffective (Crafts 2013a). Europe relies heavily on the US for new technology
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Secular Stagnation: Facts, Causes, and Cures
and its track record suggests that this will diffuse more slowly in Europe. As Table 2
reports, the OECD (2014) is hopeful that future European productivity growth will
generally better the dismal pre-crisis outcome, presumably because supply-side policy
will improve. However, this does seem to favour hope over experience, given the
protectionist and anti-market responses that the economic history of the 1930s suggests
are likely to be nurtured by prolonged stagnation.
Table 2 Pre-crisis growth and OECD long-term growth projections (% per year)
Real
GDP/
Employment,
GDP,
worker,
1995-2007
1995-2007
1995-2007
Eurozone
USA
France
Germany
UK
Greece
Ireland
Italy
Portugal
Spain
2.3
3.2
2.2
1.6
3.3
3.9
7.2
1.5
2.4
3.7
1.3
1.2
1.1
0.4
1.0
1.3
4.3
1.2
1.0
3.6
1.0
2.0
1.1
1.2
2.3
2.6
2.9
0.3
1.4
0.1
Real
GDP,
2014-30
Employment,
2014-30
GDP/
worker,
2014-30
1.7
2.4
2.2
1.1
2.6
2.2
2.3
1.5
1.4
1.5
0.2
0.5
0.3
-0.5
0.6
0.2
1.2
0.3
0.3
0.9
1.5
1.9
1.9
1.6
2.0
2.0
1.1
1.2
1.1
0.6
Sources: 1995-2007: The Conference Board Total Economy Database; 2014-30: OECD (2014, Ch. 4).
In the aftermath of the financial crisis, many European countries have high public
debt-to-GDP ratios and for those in the Eurozone extended periods of severe fiscal
consolidation lie ahead if they are to comply with the fiscal rules agreed in 2012. For
example, the OECD (2013) calculates that for every year from 2014 to 2023, Greece
will have to maintain a primary budget surplus of about 9% of GDP, Italy and Portugal
about 6% of GDP, and Ireland and Spain about 3.5% of GDP. Dealing with the debt
legacy of the crisis in this way will clearly be quite painful and is likely to undermine
growth. If fiscal stimulus is required to combat secular stagnation, these countries are
not well placed. Moreover, it is noticeable that, at high levels of debt, restoring fiscal
sustainability typically entails cuts in both public investment and education spending
(Bacchiocchi et al. 2011). The strong likelihood that post-crisis fiscal consolidation will
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Secular stagnation: US hypochondria, European disease?
undermine these expenditures does not bode well for the growth prospects of highly
indebted EU countries.
The ECB was designed to be a highly independent central bank mandated to achieve a
low inflation target. It has been reluctant to embrace quantitative easing and relatively
content with a rate of inflation close to zero. By contrast, the Fed has been far more
willing to undertake unconventional monetary policy and has a ‘dual mandate’ that
requires weight to be given to employment as well as inflation. It may be that neither
central bank is well placed to make a credible commitment to raising inflation to deliver
negative real interest rates, but the ECB is surely much the less likely to pursue the
monetary policies that the secular stagnation scenario would demand.
If adequate monetary and fiscal responses to a threat of secular stagnation in Europe
are not forthcoming, then that leaves supply-side reform, which might crowd in private
investment and/or consumer expenditure, as well as increase productivity in the long
run, as the only game in town. Such a strategy was successfully pursued in 1980s Britain
with the relaxation of credit rationing, and the relaxation of land-use planning rules could
play a similar role in Britain now (Crafts 2013b). OECD economists have quantified
the possible effects of structural reforms in European economies on productivity and in
many cases they are quite sizeable, as can be seen in Table 3. Moreover, such reforms
need not be fiscally expensive. Unfortunately, however, in practice this is unlikely to be
a feasible way to address a threat of secular stagnation, partly because the impacts are
slow to come through, but more importantly because they are politically very difficult
to implement effectively.
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Secular Stagnation: Facts, Causes, and Cures
Table 3 Potential impact on real GDP per person of structural policy reforms (%)
Labour
market
Taxation
Product
market
regulation
Education
R&D
incentives
Total
Moving to
OECD average
USA
0.3
1.4
0.0
2.5
0.0
4.2
France
Germany
UK
4.5
6.1
1.1
10.9
9.9
0.0
2.2
0.0
0.0
2.1
0.0
4.6
1.5
0.0
0.0
21.2
16.0
5.7
Greece
Ireland
Italy
Portugal
Spain
6.0
6.8
0.3
7.3
3.5
10.1
0.9
10.8
0.7
4.6
22.0
9.7
0.3
8.5
0.0
5.8
0.0
5.4
21.8
6.3
0.0
0.0
0.2
1.3
1.4
43.9
17.4
17.0
39.6
15.8
Source: Barnes et al. (2011).
In sum, it is too soon to tell whether secular stagnation is going to materialise in the
OECD economies. But it does seem clear that Europeans should be much more afraid
than Americans. The depressing effects of slower growth of productive potential will
probably be felt more keenly in Europe and economic policies to address such problems
will probably be less effective there than in the US.
References
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Secular stagnation: US hypochondria, European disease?
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